For the past decade, China has carefully opened its capital markets to foreign investors and supported controlled internationalisation of its currency, the renminbi. It started with the Qualified Foreign Institutional Investor scheme (QFII), followed by the offshore renminbi version thereof (RQFII) and the recognition of international renminbi clearing banks around the world.
Since November 2014, the Hong Kong-Shanghai Stock Connect completes this by allowing foreign investors to purchase China A-shares on the Shanghai Stock Exchange directly, using a broker based in Hong Kong.
Although few Ucits funds have made use of QFII to purchase China A-shares directly, many have bought P-notes or other China A-shares access products issued by QFII quota holders. RQFII is a success and is used in Ucits structures by RQFII managers. Numerous RQFII Ucits exchange-traded funds (ETFs), as well as actively managed funds, have flourished.
Nevertheless, the licence and quota system raises questions, namely: what happens when the quota of the manager is fulfilled? And what if a fund house does not have an entity with an asset management licence in one RQFII centre? Stock Connect provided a positive answer to these questions. It allows managers to ‘top up’ their existing RQFII China A-shares Ucits strategy via an additional and alternative channel to access those shares without using their own quota (instead, the quota of their Hong Kong brokers is used). Stock Connect also allows managers without an RQFII licence to increase their China A-shares direct exposure without having to rely on more expensive China A-shares access products.
Managers were eager to make use of Stock Connect in their Ucits. However, concerns emerged that European regulators (in particular the Commission de Surveillance du Secteur Financier of Luxembourg and the Central Bank of Ireland) might be opposed to the use of the scheme in a Ucits environment.
As a matter of fact, the review process was ongoing and a few weeks after the launch of the programme, the remaining questions from the regulator and global custodians were positively answered, allowing the first Ucits to use Stock Connect. These questions included: how shares bought through Stock Connect, physically kept in China, would be held and by which entities; the role of the Hong Kong clearing house, the Hong Kong brokers, and ChinaClear in the process; whether any of these entities would have a right of recourse in case of default of market participants in Hong Kong or China; whether delivery versus payment mechanisms could be put in place to avoid creating counterparty risks over the Hong Kong broker (where Stock Connect rules require pre-delivery for pre-trade checking); and, finally, how all this would be communicated to investors and reflected in the Ucits documentation.
At the time of writing, one Stock Connect Ucits has announced that it has been approved by the Luxembourg authorities and a number of other Stock Connect Ucits are in the process of being approved. Concurrently, a number of technical aspects are being clarified in order to enable a broader range of Ucits to make use of the scheme and a broader range of service providers to be able to assist them.
It is anticipated that the Stock Connect scheme might soon be extended to the Shenzhen Stock Exchange. It has also been reported that the scheme could be replicated in the fixed income sphere with the creation of a ‘Bond Connect’, which would allow foreign investors to access more freely the onshore renminbi debt market in their existing Ucits vehicles.
Stéphane Karolczuk head of Hong Kong office, Arendt & Medernach
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